Everything You Need to Know About Reducing Balance Method in Home Loans
Apr 18, 2017 Home Loan
Procuring home loan is a tedious yet very significant process for home buyers. For people seeking to acquire a home loan in order to purchase a property, It takes several arrangements to be made in terms of arranging guarantees, down payment amount, loan repayment capability etc. so that they fit into the lending institution’s criteria. However, home loan seekers must be aware of rules and terms put forth by the lending institution against which the loan is granted. For starters, banks charge you interest on the home loan amount either by flat interest rate or by reducing balance method. In this article we wish to enlighten our readers regarding the reducing balance method and why is it beneficial for home buyers.
Reducing balance method in home loans:
The amount collected from the home loan borrower by the lending institution every month (EMI) comprises of two main components: Principal and Interest. The amount charged as principal in EMI is deducted from the total amount of loan taken by the borrower thereby reducing the outstanding loan amount every month. It is the method by which the Interest rate is charged differs from banks to banks.
In the reducing balance method, the interest on the home loan is charged and computed on the basis of the outstanding amount (balance) of loan borrowed. EMI’s principal component reduces and the interest is charged only on the remaining loan amount.
It should be noted that higher the principal component of the EMI, greater will be the reduction of the outstanding loan amount. On the other hand, Interest component of the EMI is nothing but the charge you are paying the bank for borrowing the loan. In the reducing balance method, principal amount will be the same in each EMI whereas the interest amount will defer because it will be computed on the outstanding loan balance for every month.
In contrast to the reducing balance method, EMI being charged as per the flat interest rate will have a fixed interest component throughout the loan tenure. In this method, the interest component remains fixed irrespective of the outstanding loan amount getting reduced due to the paying up of the principal component.
Calculations of the interest in the reducing balance method depend on the frequency of the payment of principal component. Since principal payments can be made either daily, monthly, quarterly or annually the calculation of interest on the remaining loan balance is done accordingly.
Although it is recommended to choose a payment frequency that best suits your financial preferences, experts suggest to opt for daily reducing method as it is considered to be most beneficial. If you plan to make part payments, daily reducing method best serves you because of the fact that the outstanding loan amount declines the very next day after you make payment instead of at the end of that month. This will moreover result in lowering of interest component.
Important note to remember:
While choosing a lender, do not always opt for the one who offers the lowest interest rate. It is important to find out how the interest rate is calculated which will ultimately help you save more money.
Reducing balance method in home loans:
The amount collected from the home loan borrower by the lending institution every month (EMI) comprises of two main components: Principal and Interest. The amount charged as principal in EMI is deducted from the total amount of loan taken by the borrower thereby reducing the outstanding loan amount every month. It is the method by which the Interest rate is charged differs from banks to banks.
In the reducing balance method, the interest on the home loan is charged and computed on the basis of the outstanding amount (balance) of loan borrowed. EMI’s principal component reduces and the interest is charged only on the remaining loan amount.
It should be noted that higher the principal component of the EMI, greater will be the reduction of the outstanding loan amount. On the other hand, Interest component of the EMI is nothing but the charge you are paying the bank for borrowing the loan. In the reducing balance method, principal amount will be the same in each EMI whereas the interest amount will defer because it will be computed on the outstanding loan balance for every month.
In contrast to the reducing balance method, EMI being charged as per the flat interest rate will have a fixed interest component throughout the loan tenure. In this method, the interest component remains fixed irrespective of the outstanding loan amount getting reduced due to the paying up of the principal component.
Calculations of the interest in the reducing balance method depend on the frequency of the payment of principal component. Since principal payments can be made either daily, monthly, quarterly or annually the calculation of interest on the remaining loan balance is done accordingly.
Although it is recommended to choose a payment frequency that best suits your financial preferences, experts suggest to opt for daily reducing method as it is considered to be most beneficial. If you plan to make part payments, daily reducing method best serves you because of the fact that the outstanding loan amount declines the very next day after you make payment instead of at the end of that month. This will moreover result in lowering of interest component.
Important note to remember:
While choosing a lender, do not always opt for the one who offers the lowest interest rate. It is important to find out how the interest rate is calculated which will ultimately help you save more money.
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